Capital Gains & Hobbyists - Oct 2004

If you're a "hobby" breeder and thought that you could always avoid paying Capital Gains Tax ("CGT") on the sale of your foals, I've got unwelcome news for you - forget about it!

In the past 12 months, I personally, via the lodging of a private ruling request, have been seeking a definitive answer to the following question:

"If I, as a hobby breeder, spend $10,000 or less on a service fee, can the resulting foal be sold as a yearling/weanling without paying Capital Gains Tax?"

Two responses were sent back to me by the ATO in relation to this important question - the first in late December 2003, the second and final response, after their consideration of my queries to their first response, in late July 2004. It has been a long drawn out process, but at least the industry, and yours truly, now have greater certainty on this contentious issue.

This article will discuss the ATO view on this question and why I structured the question the way I did. I will round of this contribution with a useful summary of the rules relating to the deductibility of "travel expenses" for business people involved in the horse industry. Many of you have to travel extensively to conduct your horse businesses (I know I do!) and I'm sure you would like to know to what extent your air fares, petrol, accommodation, meals etc can be claimed back.

1. THE "$10,000 OR LESS" CGT EXEMPTION AND ITS APPLICATION TO "HOBBY" BREEDERS

Why did I refer to service fees of "$10,000 or less" in my question?

It has been a long held belief in the horse industry that the sale of any racehorse/foal/broodmare etc, by a "hobbyist", is not subject to Capital Gains Tax ("CGT"). Regrettably, this has never been the case.

However, a "ray of light" emerged for horse industry hobbyists via a special ATO ruling released in May of 1990. In this ruling, the ATO stated that, for the purposes of the CGT provisions, racehorses were considered to be a "Personal Use Asset". The ATO definition of a "Personal Use Asset" is:

"……an asset owned by the taxpayer and used or kept primarily for the personal use or enjoyment of the taxpayer".

As a result of this ATO categorisation, some minor concessions were now available to racehorses sold by "hobbyists". Something was better than nothing, being the general consensus in the tax community.

New "$10,000 or less" acquisition exemption from 1 July 1997

The real tax benefit for racehorses being classified as "Personal Use Assets" emerged when the CGT law was changed from 1 July 1997. From this date, any racehorse (or share in a racehorse) acquired by a "hobbyist" was exempt from CGT if it was acquired for $10,000 or less (inc GST). Thus, if a hobby owner acquired a 1/6th share in a racehorse for $10,000 or less, no CGT is payable on the sale of that interest. At last, some genuine relief for the racehorse industry and its majority of hobby owners.

What about "hobbyists" who breed a horse and sell a horse as a weanling/yearling? Does the "$10,000 or less" exemption apply?

This is the burning question that I sought an answer for, given that:

Many hobby breeders spend $10,000 or less to have a mare mated; and

Many hobby breeders are now participating in "foal share" arrangements where their contribution is only the mare and the service fee is met by the stud/stallion owner. Accordingly, the hobby breeder appears to be within the exemption rules as their "cost" is considered by the ATO as NIL.

Over the years, there has been immense conjecture as to whether a horse bred and sold as a yearling/weanling by a "hobbyist" is a "Personal Use Asset", and thus able to take advantage of the $10,000 or less exemption. My ruling application sought to resolve this conjecture.

ATO considers a foal bred for sale not to be a ""Personal Use Asset"" - "$10,000 or less" CGT exemption doesn't apply!

The ATO does not consider that a foal bred and sold by a "hobbyist" to be a "Personal Use Asset". In their opinion, only a horse that is bought and used for racing is a "Personal Use Asset", or applying the strict definition of a "Personal Use Asset", a horse bred and sold by a hobbyist is not "… kept primarily for the personal use or enjoyment of the taxpayer".

So, what are the tax implications of foals bred and sold by "hobbyists"?

In summary, these are:

Foals bred and sold by a "hobbyist" are potentially subject to CGT, regardless if the service fee cost (inc GST) is "$10,000 or less";

As foals bred and sold by a "hobbyist" are not personal use assets, a capital loss made on sale is available to be offset against gains on other capital assets (including other foals sold by the hobbyist); and

If a hobbyist breeds a foal and does not sell it, ie it is raced by the "hobbyist", such a foal will be considered as a personal use asset and will be eligible to the "$10,000 or less" CGT exemption when sold. This is very important as the ATO is willing to concede that there is no difference between a "hobbyist" who breeds a foal to race, compared to a "hobbyist" who buys a share in a racehorse either privately or via the sale ring.

Example

Alice is a "hobby" breeder and spends $8,800 (inc GST) to have her mare covered in the 2004 season.

Alice decides to race the resulting filly and after an outstanding two-year-old season, sells the filly for $200,000.

As this foal was only used for racing, it is still considered by the ATO to be a personal use asset. The service fee "cost" of the filly is "$10,000 or less", thus there is no CGT upon sale.

However, had Alice sold the filly at the 2006 yearling sales for $200,000, it is not considered to be held by her as a personal use asset and thus the filly would be subject to CGT as the "$10,000 or less" exemption does not apply.

4. Hobby breeders should seriously consider elevating their business to an ATO "business" status, now that the ATO has confirmed that they will not get CGT relief when selling their foals. I refer you to my web site at www.carrazzo.com.au if you wish to know more about what the ATO considers to be a "business" of horse breeding; and

5. Hobby breeders doing "foal shares" where they incur no service fee cost are still subject to CGT when the foal is sold as a yearling/weanling.

2. TRAVEL EXPENSES & THE HORSE INDUSTRY - DEDUCTION RULES

Travel expenses - the ground rules

Generally speaking, travelling expenses are deductible where they are incurred in the course of a taxpayer's work or in travelling between one place of business and another. Except where the expenditure falls under one of these two categories, expenditure incurred in travelling between one's home and place of work is non-deductible.

What are "travel expenses"?

Travel expenses, depending on the circumstances, could cover not only transportation costs (ie air, bus, train or taxi fares, car rentals or the appropriate portion of automobile expenses) but also, where relevant, the cost of meals, lodgings (eg hotel expenses) and travel between the lodging and the place or places of business visited while away.

The substantiation requirements as they affect travelling expenses

The Tax Act prescribe substantiation requirements which must be satisfied if a deduction is to be allowable to an employee or self-employed person for certain kinds of claims.

However, the following points are particularly pertinent to travelling expenses and should be noted:

In the case of "car expenses" the expenses must be able to be substantiated by appropriate documentary evidence and, in addition, a daily log book must be kept containing specified details of journeys which involve income-producing use of the car.

In the case of "travel expenses" relating to domestic or overseas travel which involves more than five nights away from home (eg travel to attend a yearling sale), the substantiation rules require that, in addition to the substantiation of the expenses incurred by appropriate written evidence, a travel diary or similar document be kept recording relevant details of income-producing activities engaged in while travelling.

Travel between two places of workWhere a taxpayer carries on income-producing activities in two or more different places travelling expenses incurred in travel between his various places of work are deductible.

Travel from home or usual workplace to a breeding property

Read closely, as this is the area where we get most queries from city based breeders who regularly travel to their breeding property.

The deductibility of the cost of travelling from home or from the usual workplace to a property where the breeder carries on a business of horse breeding depends on the purpose of the trip. While the cost of travel between places of employment or business are generally allowable, this may be different if, for example, the breeding property could also be regarded as a second residence or weekend retreat. In these cases, the purpose of each trip will determine whether a deduction is allowable. For example, a trip to complete renovations on a house on the property is not deductible as the purpose of the trip is not to engage in an income earning activity.

No deduction is allowable for the cost of travelling between home and a breeding property in order to perform or to supervise farming activities, as such travel is generally considered to be for the purpose of merely transporting the person to the place where the income producing activities commence. However, a deduction is generally allowable for: (a) any trip where bulky farm goods and equipment are carried (unless there is a reasonably secure storage area on the property); (b) for travel from home to inspect a breeding property which is rented to a tenant farmer; or (c) if the taxpayer's home is also the base of operations for several farming or other businesses (ie not just a horse breeding property), even if the taxpayer supervises or carries out work on the property.

Example- Doctor/grazier's claim allowed

In an actual tax case, the taxpayer, a doctor who also carried on a farming and grazing business, was allowed a deduction of $23,300 for his expenses in using an aircraft as a means of transport in his two businesses. The doctor lived on a country property where he ran a farming and grazing business. He carried on a medical practice in Sydney and also in various country centres including his home town. He leased an aircraft to fly himself to and from the various centres and also in connection with his farming activities. It was accepted that he would not have been able to meet the demands of his medical practice and his farming business if he had to rely on other forms of transport and that it was only because the taxpayer had the aircraft available that he was able to carry on practice at the various centres and to manage his farming business properly.

Travel where home is place of workAs noted above where a taxpayer travels between two places of work that expenditure is deductible, and it makes no difference if one base of work is also his residence.

It is a question of fact in each case whether the taxpayer can establish that his home is a site from which his income producing activities are in fact undertaken.

Tax Office policy where home is a place of work

The ATO will generally allow a deduction for the cost of travel between a home-based employment or business and another place of employment or business. However, the fact that a room in the breeders home is used in association with a breeding business conducted elsewhere will not be sufficient to establish entitlement to the deduction.

Where a breeder is engaged in full-time employment away from home, or conducts a business away from home, and also carries on a part-time income-producing activity at home, a deduction will not generally be allowed. An exception is where there is some particular aspect of the travel which makes its cost deductible, eg the cost of floating a horse to a Vet on the way to the full-time employment or business would be deductible.

Travel between place of employment or business and residence on which the taxpayer carries on a breeding business

The cost of travelling between a place of employment or business and the breeders residence at which a breeding business is carried on is generally not deductible. However, a deduction may be allowable for the cost of particular trips in the following circumstances: (a) if the taxpayer is undertaking some significant primary production-related activity such as carrying produce or stock to market or carrying feed or veterinary supplies home; or (b) if there is sufficient nexus between the travel and the employment of the taxpayer, such as where the taxpayer's employment is itinerant or where the home constitutes a base of the non-primary production business activities or employment

Example 1 - Travel between farm and city job

In another actual case, the taxpayer, who lived on a farm on which he kept cattle, sheep and pigs, claimed his travel costs from the farm to his full-time job in the city. It was held that where the travel related simply to the transport of the taxpayer to his city job the expense was not deductible. However, the cost of those trips on which the taxpayer carried in his car large farm items or stock eg fodder, bales of wool and livestock qualified for deduction.

Example 2 - Breeder travels directly between farm and work

Peter lives in the city where he works during the week as an accountant. On the weekends, he lives on his farm in the country at which he carries on a horse breeding business.

On Friday nights, Peter travels directly from his workplace (in the city) to the farm. On Monday mornings, he travels directly back to his place of work (in the city) from his farm.

Under current tax laws, Peter will not be entitled to claim a deduction for his travel between his work (in the city) and the farm. This is because Peter's farm (being a place of business) is a place at which he lives (even though this is only on a temporary basis).

Furthermore, no deduction is allowed to Peter as a result of a recent High Court decision.

What if Peter was required to pick up veterinary supplies and supplements for his horses, once a week, on his way to the farm from work?

Even though the trips from work to the suppliers and then to the farm are not deductible under some tax laws, Peter can claim a deduction for the cost of these trips under the general tax provisions.

It would be argued that Peter has actually commenced performing his farming or business duties when leaving work in these circumstances.

What if Peter was required to visit a client on the way to work on a Monday morning?

Peter can claim a deduction for the cost of this trip, providing he is performing "substantial" duties at the client's premises.

Expenses incurred by a taxpayer in attending a convention relating to his or her business or employment may qualify for deduction. The fact that vacation or leave time is utilised in attending a conference or that attendance is voluntary will not necessarily preclude deduction. Where only part of the purpose of the trip is attendance at the conference, the expenses may be apportionable.

Airfares - are they fully deductible?

Where a breeder undertakes an overseas trip partly for the breeding business and partly for pleasure, the question arises of how the airfares should be apportioned. The ATO has ruled that if the trip would not have been made but for the breeders desire to engage in some business activity, and the private activity is merely incidental, then it may be appropriate to allow a deduction in full for the cost of the airfares; in other cases, the cost is to be apportioned.

You are welcome to contact me if you wish me to clarify or expand upon any of the matters raised in this article.

DISCLAIMERAny reader intending to apply the information in this article to practical circumstances should independently verify their interpretation and the information’s applicability to their particular circumstances with an accountant specialising in this area.

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